In China,off-balance-sheet lending risks lurk in the shadows

But the key question is no longer how much risk banks are carrying. Rather,its how many risky loans have been shifted to the lightly regulated shadow banking institutions mainly trust companies,brokerages and insurance companies. The risk to the overall financial system is not clear,because of insufficient data about the quality of credit in the shadow banking sector.

Trust companies and brokerages probably arent buying many bad loans directly,analysts and industry executives say,but they have become a vital source of credit,allowing banks to arrange off-balance-sheet refinancing for maturing loans that risky borrowers cannot repay from their internal cash flow.

Without these institutions,the amount of NPLs might have been much higher,though no one is quite sure how high.

Trust assets increased 55 per cent in 2012 to 7.5 trillion yuan 1.21 trillion,according to the China Trustee Association,while funds entrusted to brokerages by banks soared more than fivefold to 1.61 trillion yuan.

There is absolutely an impact on NPL figures from the ability to offload stuff through these channels, said Charlene Chu,China banks analyst for Fitch Ratings. Trust companies sell wealth management products WMP to raise funds so they can purchase loans that banks want off their books. WMPs are then marketed through bank branches as a higher-yielding alternative to traditional bank deposits.

These bank loans are not being repaid by the borrowers; theyre being repaid by investors in the wealth management products. So we really cant see what the true corporate repayment rate is, said Chu.

In 2010 and 2011,analysts began fretting about the large volume of loans to local governments and state firms doled out as part of Chinas massive economic stimulus plan from 2008 to 2010 8211; that were due to mature in 2012. But the wave of defaults never materialised,in large part because banks,working with trusts and brokerages,provided fresh funds to enable borrowers to refinance their debt. Industry executives say at least half of trust company assets and 80 percent of brokerages entrusted funds are related to so-called passageway business.

In passageway deals,trusts and brokerages cooperate with banks to act as passive reservoirs for loans that banks originate but cannot keep on their own balance sheets without running afoul of lending quotas,capital adequacy requirements,and loan-to-deposit ratios.